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October 24, 2011

JPMorgan's Kelly: Housing Market Turnaround Is at Hand

After years of housing market decline that has weakened the economy and depressed consumer sentiment, a number of analyses are strongly suggesting that a turnaround in the beaten sector may finally be at hand.

Indeed, the market seems to be adding its endorsement to these analyses, with the SPDR S&P Homebuilders ETF (XHB) up 23% in the past month. (Even with the recent surge, the index is down more than 50% over the past five years.)

In a sweeping report titled “Housing: A Time to Buy,” JPMorgan Asset Management analysts David Kelly and David Lebovitz argue that trends in supply, demand and inventories all point to rising home prices. The two analysts offer lots of data that show how extreme the changes in the housing market have been in recent years. Their conclusion is shared by their counterpart, Citi analyst Joshua Levin (see more on Levin's research on the next page).

Take housing starts, for example: The best month in the past years of housing crisis resulted in just half the average level of building activity over five decades. Kelly and Lebovitz present the data as follows: “In almost 50 years, from January 1959 to September 2008, the lowest annualized rate of housing starts recorded for any month was 798,000, and the average rate was more than 1.5 million units. Since January 2009, the highest rate recorded for any month has been 687,000, and the average rate has been just 575,000."

Other stark findings include the fact that the value of home equity today totals less than half the level reached in 2006 --$6.2 trillion compared to $13.5 trillion five years ago. And the effect of the housing bust has been profound in that the fall in construction employment alone accounts for 30% of U.S. job losses in a sector that accounted for no more than 5.7% of U.S. jobs at its peak. All these and many more statistics account for today’s depressed consumer sentiment, whose current index value of 57.5 is nearly 30 points below its average of the past 40 years.

From an investment point of view, the JPMorgan valuation data is similarly robust. Kelly and Lebovitz show that the ratio of median home prices to personal income over the past 45 years has hovered over 200% (and peaked at 251%), but has fallen now to a historic low of 153%. To get back to a normal ratio, home prices would have to rise by 27%, they say. And with the fall of mortgage rates, mortgage payments for the median home have fallen to just 6.9% of personal income – a ratio of less than half the 14.4% average since 1996.

Comparing mortgage payments to rental rates, the JPMorgan analysts show that “home prices would have to rise by 35% just to get back to their average relationship to rents.” Kelly and Lebovitz also compare prices to the cost of construction – “a sort of price-to-book ratio for the housing market” – and find that housing today costs just 26% more than the cost of rebuilding compared to an average 55% premium since 1975.

The JPMorgan analysts also look at home inventories, which remain high, but they show these inventories in rapid decline – a conclusion shared by their counterpart, Citi analyst Joshua Levin who, in a report highlighted by Business Insider, calls the lowest inventory of homes for sale in September since 2005 “the most interesting thing you may not know about the housing market.” Business Insider’s Joe Wiesenthal has also reported on still another uber-bullish case for housing by Harvest Capital, which similarly points to favorable valuations, declining inventories and increased demand.

JPMorgan’s Kelly and Lebovitz bring much more data in their analysis, but they distill their points in the conclusion of their report: “Home prices, housing demand and home building are very low, but they all seem set to increase. Housing inventories remain too high, but they are on a downward trend. And while the attitudes of both home buyers and home lenders remain very cautious, they should become less so in the years ahead.”

Their bottom line is that just as the peak of the home-buying euphoria five years ago was a time to rent, current data suggest that housing today is a strong buy.

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